Economic Insight April 20, 2018

Economic

Commentary Economic Insight April 20, 2018

LINDSEY M. PIEGZA, PH.D. The Changing Face of the Fed HIEF CONOMIST C E Economist Estimates (312) 454-3873 Economic Data Calendar Prior High Low Median Stifel [email protected] Monday 23-Apr Chicago Fed Nat Activity Index - Mar 0.88 0.50 0.21 0.25 0.25 Existing Home Sales - Mar 5.54m 5.60m 5.39m 5.55m 5.51m Existing Home Sales MoM - Mar 3.0% 1.1% -2.7% 0.2% -0.5% Tuesday 24-Apr FHFA House Price Index MoM - Feb 0.8% 1.2% 0.4% 0.6% 0.5% S&P CS 20-City MoM SA - Feb 0.75% 0.80% 0.50% 0.60% 0.50% New Home Sales - Mar 618k 650k 600k 630k 624k New Home Sales MoM - Mar -0.6% 5.2% -2.9% 1.9% 1.0% Richmond Fed Manufact. Index - Apr 15 20 16 16 16 Conf. Board Consumer Confidence Index - Apr 127.7 129.0 123.0 126.0 125.0 Wednesday 25-Apr Thursday 26-Apr Initial Jobless Claims - Apr 21 232k 235k 225k 230k 230k Wholesale Inventories MoM - Mar P 1.0% ------0.8% Durable Goods Orders - Mar P 3.0% 4.0% -0.3% 1.1% 0.8% Durables Ex Transportation - Mar P 1.0% 1.0% 0.0% 0.4% 0.2% Kansas City Fed Manf. Activity Index - Apr 17 ------15 Friday 27-Apr GDP Annualized QoQ - 1Q A 2.9% 2.8% 1.5% 2.0% 1.5% U. of Mich. Consumer Sentiment Index - Apr F 97.8 102 97.2 98.0 98.0 Source: Bloomberg, Stifel

On the surface, the Fed continues to posture support for additional rate hikes in 2018. Furthermore, the appearance of a united front has perpetuated inventors’ anticipation of an additional backup in rates; according to Bloomberg, the forward curve is now implying a faster pace of hikes than previously forecasted at the start of the year. The pathway for rates, however, is far from certain, as the dispersion of the dots in the plot clearly suggests. There are a number of sizable barriers including modest growth, a flatter curve and a changing composition of Fed leadership that could undermine the Committee’s presumed eagerness to increase Fed funds twice more in the remaining eight months of the year.

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Modest Growth and a Flatter Curve At this point, nine years into the “recovery,” economic conditions are far from robust. By the Committee’s own characterization, the economy remains “moderate,” creating little sense of urgency to further remove accommodation. Additionally, despite the recent backup in nominal rates, additional upward pressure on the short-end has resulted in an increasingly flatter curve. As of late, the spread between 2yr and 10yr treasury yields fell as low as 41 basis points, the narrowest differential since 2007, before the financial crisis. A further reduction of the 2s10s yield spread threatens a possible curve inversion, a phenomenon investors and Fed officials alike are well aware has historically signaled a weakening longer-term outlook for the U.S. economy and preceded every economic recession in post-WWII history. While hardly a perfect one-for-one exchange, such a minimal gap between short-term and long-term rates affords the Fed limited opportunity to continue to remove accommodation, let alone hike two more times this year without further risking an outright inverted yield curve. As John Williams noted earlier this week at a NABE event, a truly inverted curve “is a powerful signal of recessions” that historically has occurred “when the Fed is in a tightening cycle, and markets lose confidence in the economic outlook.”

Changing Look of the Fed The composition of the Fed may also prove a restriction to more aggressive policy. Federal Reserve district presidents vote on a rotating annual basis – save the New York Fed president who has a perpetual vote. This year, some of the more hawkish district presidents such as Philadelphia Fed President Patrick Harker and Dallas Fed President Robert Kaplan1 are rolling off of the voting bloc, replaced by more centrist or dovish leaning presidents such as Atlanta Fed President Raphael Bostic and San Francisco Fed President John Williams.

Additionally, there are four longstanding vacancies on the Federal Reserve’s Board of Governors. Such vacancies were left by the departures of Stanley Fischer and Daniel Tarullo last year, and Jeremy Stein and Sarah Bloom Raskin back in 2014. The Trump administration now has the rare opportunity to stack the proverbial Fed deck, so to speak, with like-minded individuals focused on prolonging or perpetuating the U.S. “recovery.” Thus far, the president has offered nominations to

1 Dallas Fed President Robert Kaplan is usually thought of as a centrist although he has recently spoken in favor of potentially three rate hikes this year.

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three of the vacancies, two as recent as this week. And, unlike district presidents who are nominated by an internal search committee formed by the Reserve Bank's board of directors and then confirmed by the Board of Governors to a five-year term, governors are nominated by the president and confirmed by the Senate to a fourteen-year term! In other words, the administration is choosing individuals who could have a significant influence on policy not only in the near term, but on the outlook for rates for the foreseeable future.

This week we take a look at the potential newest members for the Federal Reserve’s Board of Governors.

Federal Reserve Nominees

Marvin Goodfriend was nominated to serve on the Federal Reserve Board of Governors in November 2017. The Senate Banking Committee approved Goodfriend’s nomination on February 8th in a 13-12 vote, however, he has yet to be confirmed by the full Senate.

Goodfriend is an economics professor at Carnegie Mellon University where he has taught for the past thirteen years. Prior to his role at Carnegie Mellon, Goodfriend was director of research and policy adviser at the Federal Reserve Bank of Richmond for twelve years beginning in 1993. Earlier, Goodfriend was a visiting economist at the Federal Reserve Board in 1982-1983 and served as a senior staff economist on the Council of Economic Advisors under President Reagan in 1984-1985.

Goodfriend received a B.S. in mathematics from Union College and later earned a Ph.D. in economics from Brown University. To note, while Powell is the first Chair of the Federal Reserve to reign without a Ph.D. in economics since Paul Volcker in the 1980s, Goodfriend is the first Trump appointee to the board to possess such a designation.

Goodfriend has been both vocal and transparent in his views regarding monetary policy. He has voiced continued support for a more rules-based approach to policy adjustments, removing some of the undue uncertainty resulting from individual policy perspectives. Goodfriend has called for Congress to mandate a 2% inflation target into law and for the Fed itself to accept the inflation target to further enhance the central bank’s “credibility.” Speaking before the House Financial Services Committee on March 16, 2017, Goodfriend suggested that the Fed should “strengthen the legislative oversight process to help enforce the systematic pursuit of monetary policy.” Goodfriend has also suggested that he favors unconventional policy initiatives to combat weakness in the economy, including but not limited to negative interest rate policy.

A more recent nomination, Richard Clarida has been selected to serve as Vice Chairman of the Federal Reserve. The position of Vice Chairman has been vacant since October 13, 2017 when Stanley Fischer stepped down for personal reasons, well before his term was set to expire on June 12, 2018. In the interim, New York Federal Reserve President William Dudley has been acting Vice Chairman.

Richard Clarida is an economist at Columbia University where he has taught since 1988. Currently, Clarida also serves as managing director and global strategic adviser at Pacific Investment Management Company (Pimco). Earlier in his career, Clarida acted as assistant Treasury secretary for economic policy under the Bush administration from 2002-2003 and

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as a senior economist on President Ronald Reagan's Council of Economic Advisers from 1986-1987.

Richard Clarida received an undergraduate degree from the University of Illinois and later earned a doctorate from Harvard University.

Clarida is considered to have a “centrist and pragmatic” view of monetary policy. Clarida is known as a moderate Republican, however, according to the WSJ, he is respected by economists on both sides of the political spectrum. Furthermore, according to those familiar, Clarida is thought to provide a welcome balance to Fed leadership given his dual experience in both academia and finance; Clarida is expected to be open to a more “realistic” assessment of monetary policy as opposed to a more model-driven policy approach.

Additionally, according to reports, the Obama administration had considered nominating Clarida for a seat on the Federal Reserve Board of Governors in 2011, but instead opted to nominate now Chairman Jerome Powell to fill the position.

Along with Clarida, the administration announced its nomination of Michelle “Miki” Bowman earlier this week. Bowman has been nominated to fill the designated community banker seat on the Federal Reserve Board of Governors. A 2014 congressional requirement reserves one seat on the Board of Governors for a community banker; the seat, however, has never been filled.

Bowman is currently the State Bank Commissioner for Kansas. Prior to becoming Commissioner in 2017, Bowman served as vice president of Farmers and Drovers Bank in Council Grove, Kansas, an institution owned and run by her family since 1882. Prior to her role at Farmers and Drovers Bank, she ran a government and public affairs consultancy in London from 2004-2009. Before that, Bowman worked for Senator Bob Dole in Washington, DC and served as a counsel to the U.S. House Committee on Transportation and Infrastructure as well as the Committee on Government Reform and Oversight. Earlier, Bowman was appointed by President George W. Bush to serve at the Federal Emergency Management Agency as Director of Congressional and Intergovernmental Affairs, and spent roughly two years working at the Department of Homeland Security as Deputy Assistant Secretary and Policy Advisor to Secretary Tom Ridge.

Bowman attended the University of Kansas earning a B.S. in advertising and journalism. She later attended Washburn University School of Law where she earned a Juris Doctorate.

At this point, Bowman’s views on monetary policy are mostly unknown. With a background in business and banking, however, Bowman is expected to have a more “business friendly” mindset when it comes to regulations and restrictions on financial institutions.

-Lindsey Piegza, Ph.D., Chief Economist

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Economic

Commentary Economic Insight April 20, 2018

Glossary B.S. – Bachelor of Science FOMC – Federal Open Market Committee NABE – National Association for Business Economics WSJ – Wall Street Journal

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This material is prepared by the Fixed Income Strategy Department of Stifel Nicolaus & Co (“Stifel”). This material is for informational purposes only and is not an offer or solicitation to purchase or sell any security or instrument or to participate in any trading strategy discussed herein. The information contained is taken from sources believed to be reliable, but is not guaranteed by Stifel as to accuracy or completeness. The opinions expressed are those of the Fixed Income Strategy Department and may differ from those of the Fixed Income Research Department or other departments that produce similar material and are current as of the date of this publication and are subject to change without notice. Past performance is not necessarily a guide to future performance. Stifel does not provide accounting; tax or legal advice and clients are advised to consult with their accounting, tax or legal advisors prior to making any investment decision. Additional Information Available Upon Request.

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